Save Smart for Retirement

Although many people want to retire comfortably, saving the funds needed to do so can be a challenge. Fortunately, there are some simple strategies that people can use to increase the odds that they will be able to save the money they need in order to retire.

Saving Is Important 

Building a cushion of savings is important so that people have a safety net, and they also need these funds if they want to invest. By using some straightforward tips to save, they will hopefully have some added motivation to put more way.

Spend More Effectively

One way to increase the fraction of your income that goes into savings is to spend more effectively. People can make improvements by reviewing their expenses and identifying alternatives that are cheaper and are not substantially different. Once these items have been identified, people can use the extra funds generated to pay for things that are more important to them.

If an individual has more than one brokerage account, he can consolidate these accounts so that the higher level of assets provides them with services that are either cheaper or better.

Don’t Wait for the Perfect Plan 

Many individuals fail to take action because they are holding out for the perfect plan. The drawback to this is that the longer they wait to improve their habits for spending and saving, the more money they will end up throwing away.

This principle also applies to investment plans, in that people fail to invest simply because they do not feel they have the perfect plan established. A lot of individuals do not invest because they are worried about making mistakes, but a plan is needed for retirement to be realized.

Continuous Refinement Is Key

Even if an individual has worked out a plan that he considers to be ideal for his situation, assets, goals and tolerance for risk, this plan can become outdated. Technological advancements provide individuals with more options over time, and new investment vehicles are always being created.

When possible, people who are saving for retirement should review their plans in order to see where improvement can be made. There are many investment mistakes that can be made, and people need discipline to ensure that their investment plans do not fall off track.

Savings are important, especially in the face of dwindling pensions and widespread concerns about the prospects for retiring. The doubts that many individuals have about their ability to retire were reflected in a recent Wells Fargo poll, in which 75 percent of respondents predicted that they would still be working during years that people usually use for retirement and an additional 25 percent said that they planned to retire no earlier than 80.

Could you retire in your 30s?

This article by Andrea Coombes for MarketWatch covers the story of a young couple who decided to retire early.  No, they did not retire at 60, or 50, or even 40.  They decided to quit work in their 30s.  Their goal was to amass roughly 25 times their annual spending.  They reasoned that if they could live simply and frugally, on roughly $25,000 a year, they could aggressively save enough to retire from their demanding jobs in the technology industry.  This would allow them to both be active in raising their 8-year-old son.

Retirement is a math problem.  How you live before and after retirement is part of the equation.  If you can live on a very small budget, you can possibly retire early.  One rule of thumb is to accumulate savings of roughly 25 times your living expenses. In their case, they paid off their home and reached the $600,000 target, so they decided to take the plunge.  They now live primarily off their investment income and temporary jobs they take, as needed or as desired, for extra income.

This story underscores that in order for people to decide when they can retire, they need to know two things– how much they realistically need in terms of living expenses and how committed they are to saving aggressively to reach their goal.

It ultimately depends on your cash flow, which is the lifeblood of the financial plan.  You need to enhance your awareness of what is coming in and what is going out.  How much money do you really need to live on in a year’s time?  How much of your salary are you saving? (My guess is that this couple was saving well over 25% of their gross salary annually.)  How motivated are you to reach your retirement goal?  Since this couple had visualized and articulated their plan to retire early they had a burning and shared desire to accomplish their goal.

Unfortunately, procrastination and a tendency to focus on current wants and needs as opposed to future plans can derail the best intentions.

Many workers think that as long as they save the maximum amount in their workplace retirement plan, it will be enough to provide sufficient income in retirement.  But it really depends on their annual spending.  For example, a professional couple spending $400,000 a year will have a hard time obtaining adequate income from a $2 million retirement plan once they retire.    Remember, too, that a $2 million IRA or 401K is not totally available for income.  You need to take the after tax amount into consideration.  Two million dollars at a 32% tax rate (federal and state) would only be equivalent to $1.4 million.

Furthermore, in order to ensure that your funds will last you 30 years, you should probably only withdraw roughly 4% of the total, which would be $80,000 before taxes and roughly $55,000 after taxes.  That is a large drop in income for someone who is used to spending several hundred thousand dollars a year.

Many of us will also need to save after tax dollars, as well as contribute to our retirement plans, in order to provide adequate income as well as flexibility regarding taxation of withdrawals in retirement.  Since this couple retired so early with significant funds, it is likely the bulk of their savings was in after tax accounts.  This helps minimize the tax impact of any withdrawals from their savings.

In the end, it all comes down to a trade-off between your lifestyle now and your lifestyle in retirement.  If we delay gratification now, we can meet our future goals.  If we want to live a simple lifestyle, it will likely be easier to retire early.  If we have large spending needs in retirement, we will need to save more or retire later in life.

It will be interesting to see how this couple continues to navigate their frugal journey, especially as expenses rise over time.  Their child will likely want to engage in sporting activities, hobbies, video games, and attend college.  The future may also bring unexpected medical and long term care expenses.

Plus, there are definitely downsides to such an early retirement.  I am not sure a life of leisure would be suitable for most young people, as achievement, socialization, and other benefits from working can be beneficial to one’s physical health and emotional well-being. Furthermore, if a worker remains out of the work force for even just a few years, his skills may become irrelevant, such that he becomes unemployable.

I admire the couple’s ability to save and reach their goal and wish them much success in their endeavor.  I hope that in the long term their “hiatus” works for them.  My guess is that this couple will eventually decide to go back to work.  Saving for 10 to 15 years so that you can live possibly the next 70 years seems like a tough math problem to solve.  But adhering to these principles can help us all manage our own retirement math a bit better.

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